Will “Starmergeddon” unleash “Burnhamflation” on hapless UK savers and investors? It feels good to ask, if only so that I can jam two words together in a new coinage as journalists like to.
It is true that last week there was an increase in key gilt yields, which move inversely to prices. Some of that can be attributed to the possibility that one worried, bespectacled Labour Party veteran will replace another as UK prime minister.
Andy Burnham would probably tax and spend more than Keir Starmer, thereby increasing inflation. But the impact of his candidacy was reflected in a mere 3.5 per cent increase in the 30-year gilt yield on Friday. By closing the Strait of Hormuz, the US and Iran had already pushed it up by more than 12 per cent.
Consumer price inflation had been running at 3.3 per cent, much higher than forecasts. This is a pain for savers and investors like me. Is there any way of protecting ourselves?
I looked for clues in the annual real returns on three main asset classes — cash, stocks and bonds — over the past three decades.
Sitting on cash is a good way of damping short-term volatility and a bad way of protecting against inflation over a longer period. During the 2010s, for example, inflation ran ahead of low daily benchmark rates.
Some retail depositors did better during the decade, according to Adam French of Moneyfacts, a data provider. The average one-year fixed-rate account held its value. Steeper inflation flipped the picture from 2020, he found, with the average one-year fixed-rate account losing a tenth of its value.
No one regards cash accounts as consistent inflation beaters. In contrast, equities enjoy some of that status. As the chart shows, even much-derided UK shares generally increase in value in real terms over time.
The short-term volatility of equities — including some spectacular crashes — will alarm sensitive readers. Unfortunately, there is no definitive answer to the question: “How long do I need to hold stocks to defeat declining purchasing power and volatility?”
Richard Maitland of Sarasin & Partners, a wealth manager that produces an annual compendium of historical investment returns, cites a useful rule of thumb: “On a one-year basis, equities only protect your money 65 per cent of the time,” he says, “But if you think in seven-year rolling averages, shares protect you 82.5 per cent of the time.”
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One could, in theory, tilt a portfolio towards shares that have purported inflation-beating qualities. These include businesses with index-linked service contracts. But it seems silly to me to invest in privately owned UK utilities. A Burnham-led government might nationalise some water utilities to punish them for dumping poop in the rivers.
You already get inflation-proofing from fractional ownership of a diverse group of shares. As steadily-rising inflation hits companies via steeper input costs, such as pricier labour and materials, companies seek to protect the cash profits that produce dividends by putting up their own prices. The caveat is that wild inflation can wreck the cosy arrangement by damaging business and investor confidence.
Gold is the other asset routinely trumpeted as an inflation beater. I am not convinced. Even the World Gold Council, which promotes the commodity, noted in 2021: “For all the talk of gold as an inflation hedge, its relationship to changes in [US] consumer price inflation is surprisingly poor.”
You could argue that fixed-rate bonds, including gilts, are a more obvious hedge. Multi-year investment should raise the purchasing power of your capital via higher coupons on new issues of debt. Unfortunately this is heavily offset by falls in the value of bonds you already hold when the inflation outlook worsens, as per Liz Truss’s disastrous 2022 “mini-Budget”.
Inflation-linked bonds of the kind issued by governments might sound like the solution. Here, coupon and principal repayments generally increase in line with rising prices. You can therefore imagine investors crying “Begone, depreciating capital misery!” while splurging on these securities.
There are a couple of objections. “Suppose the central bank puts up real interest rates by more than the increase in inflation to keep the latter in check,” explains Markus Heider, rates strategist at Deutsche Bank Research. “The bond compensates the investor for inflation but not the additional increase in real rates.”
The other issue, which applies in particular force to UK index-linked gilts, is that like any specialised investment they can be hit by brute forces of supply and demand.
Baaing anxiously, flocks of mature pension funds buy lots of exposure to these securities in an effort to match their liabilities. Or they do until prices wobble, forcing the funds to put up extra capital by dumping some of their “linkers” and starting a rout in the securities. That was another of 2022’s financial disasters. The Bank of England had to intervene.
Where does this leave investors? Burnham, met with bond market turbulence, has meekly promised to stick to fiscal rules. But inflation induced by the US-Iran war marches on.
Personally, I am sticking with my investments as they stand. I have a chunk of cash in a few higher-yielding accounts and some underperforming bond funds. This is for the purposes of diversification, not inflation proofing. Stock markets are high and I am already decumulating.
The bulk of my money is in UK and US equities. These, I believe, are reasonably safe from inflation, if not from geopolitical shocks and market crashes. The first risk is one I believe I can assess and mitigate. New Trumpian wars and the implosion of the artificial intelligence financial bubble are far harder dangers to get my head round.
Jonathan Guthrie is a journalist, adviser and the author of “The Truth About Investing”. [email protected]
